NEW YORK - Basic securities analysis textbooks assume that investors sell to investors that think like them. That is long-term, even though the eventual buyer may be another company in a merger or acquisition. One of the nice things about life and markets is that each year brings new people wanting to invest.
Each generation produces young people wishing to get rich quickly, who believe that making smart decisions and acting very quickly pulls off that trick. Wouldn’t we all like to find El Dorado, the mythical gold mine?
While sheltering in place, the youth discovered their brokerage firms allow them to trade on margin. Stocks and bonds cost too much money and move too slowly, so they quickly discovered put and call options. Options normally expire worthless or are sold, but they can require delivery or acceptance of the underlying shares.
To protect the sellers of these options they buy or short the underlying shares. During the last two weeks the market has become aware that in aggregate these options, plus some owned by a large Asian fund group, is huge. This is one of the explanations of the two-tier market we have been experiencing.
The first tier is about ten stocks, including a couple of Asian companies. Through the end of August these stocks gained much more than +20%. The remaining stocks, the second tier, is still down a few percentage points year-to-date.
Our intrepid youth has concentrated their attention on these tech leaders in the first tier. Options are written for various time periods, from a day to multiple years. Most institutions using options typically hold them for one or two months, but these youth are often in and out within two days. A complicating issue is the belief that the equity underlying these trades, on both the buy and sell side, could be as low as 7%.
This in and of itself is causing rapid trading on the other side of these transactions. Short-term traders expect the other side of their trades to be similarly motivated by short-term views. During the last two weeks this has been the added increment to the market, adding to both volume and probably much more to volatility.
The time hurdles
Added to this, we have entered an emotional trading period which can last until mid-November. By the end we will have the initial results of the US election.
We are also likely to get frequent reports on the progress of vaccine trials and therapeutics, which are not as much in the news but possibly more important in terms of the number of people treated.
Personally, I am very concerned with the execution of production and distribution of these lifesaving or at least life altering medicines. These are very large tasks that frequently run into problems.
Other news elements before 2021:
- Brexit + UK Economic Recovery Faster than Continent
- Some rising commodity prices affecting some consumer prices
What should investors do?
Traders should trade, but remember, they want to finish with cash in the end. Investors should sit through this emotional trading period unless the market moves 20% either way. If a specific issue has some unexpected news causing re-interpretation of the situation, perhaps some change might be warranted.
In general, sound investors with good portfolios and not too much cash should use a 20% market gain to add to reserves. Investors should use a 20% market drop to look for new bargains, which will benefit quickly if the market adapts to new strategies.
A former president of the New York Society for Security Analysts, Michael Lipper was president of Lipper Analytical Services Inc. the home of the global array of Lipper indexes, averages and performance analyses for mutual funds. His blog can be found here.